CESTAT Chennai rules on valuation of free customer drawings and extended limitation under Central Excise

Background of the dispute

The Chennai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) decided an appeal filed by Fritzmeier Motherson Cabin Engineering Pvt. Ltd. against Order in Appeal No. 53/2018/Audit-II dated 01.03.2018, passed by the Commissioner (Appeals), Commissioner of Central Excise, Service Tax and GST, Chennai.

The assessee manufactures motor vehicle cabins and cabin parts and was registered with the Central Excise authorities for this activity. During departmental audit, it was noticed that:

  • The assessee was receiving certain inputs as well as designs and drawings for motor vehicle cabins free of cost from its customers (Original Equipment Manufacturers – OEMs).
  • The assessee loaded the value of free inputs into the transaction value while determining assessable value.
  • However, the assessee did not amortise or include the value of free-of-cost designs and drawings in the assessable value of the cabins.

The Department took the view that this omission violated Rule 6 of the Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000, as these designs and drawings allegedly constituted “additional consideration” under Section 4 of the **Central Excise Act, 1944`. On this basis, a Show Cause Notice dated 26.10.2015 was issued, proposing:

  • Demand of excise duty of Rs.22,49,164/- for the period October 2010 to March 2015,
  • Recovery of interest, and
  • Imposition of equivalent penalty under Section 11AC,
  • By invoking the extended period under the proviso to Section 11A(1).

The Adjudicating Authority, vide Order in Original No.13/2017-CE dated 10.03.2017, confirmed the duty demand of Rs.22,49,164/- along with interest and imposed an equivalent penalty under Section 11AC.

In appeal, the Commissioner (Appeals) found that the method adopted for quantifying the amortised value of drawings was not correct, but nonetheless remanded the matter to the Adjudicating Authority for re-determination of amortised cost and redetermination of duty liability.

The assessee challenged this appellate order before CESTAT Chennai.

Issues before the Tribunal

The Tribunal identified three core questions for determination:

  1. Valuation issue
    Whether the notional value of designs and drawings supplied free of cost by customers is includible in the assessable value of motor vehicle cabins under Section 4(1)(b) of the Central Excise Act, 1944 read with Rule 6 of the **Central Excise Valuation Rules, 2000` (as applicable during the relevant period).

  2. Quantification issue
    Whether the 0.98% loading adopted by the Department, based on a percentage suggested by a single customer, constitutes a valid determination of value under the Act and the Valuation Rules.

  3. Limitation and penalty
    Whether the extended period of limitation under the proviso to Section 11A(1) was validly invoked, and whether penalty under Section 11AC was consequently sustainable.

Department’s quantification approach – 0.98% loading

Basis adopted in the Show Cause Notice

To determine the alleged money value of designs and drawings, the Department contacted the assessee’s customers. One such customer, M/s. Mahindra and Mahindra, responded that:

  • It was difficult to determine the value or amortised cost of cabin drawings;
  • The development cost of motor vehicle parts had not been identified separately; and
  • The total development cost for tractors worked out to 0.98%, and this percentage “might be considered” for working out the value of cabin drawings.

The Department lifted this 0.98% figure and applied it uniformly to the value of all cabins cleared to all customers during the period in dispute. No other evidence of value was cited in the Show Cause Notice. The Adjudicating Authority treated this as a “best judgment” assessment on available facts.

The Tribunal later scrutinised whether such a percentage-based loading, based on a suggestion of one customer and relating to tractor development cost, could qualify as a legally acceptable valuation method under the Central Excise regime.

Transaction value vs. additional consideration

Section 4(1)(a) of the Central Excise Act provides that transaction value is the measure of duty when:

  • Goods are sold for delivery at the time and place of removal;
  • The assessee and buyer are not related; and
  • The price is the sole consideration for the sale.

Only if these conditions are not met, does Section 4(1)(b) read with the Valuation Rules apply to determine value.

In this case:

  • It was never disputed that the assessee and its customers are unrelated persons.
  • The entire Revenue case hinged on whether the price was the sole consideration, i.e., whether free-supplied designs/drawings constituted additional consideration.

Explanation 1 to Rule 6

Rule 6 (as then in force) deals with sales where buyer and seller are not related and price is the sole consideration, and also addresses situations where additional consideration flows from buyer to assessee.

Explanation 1 to Rule 6 deems the money value of additional consideration to include, inter alia:

  • Goods and services supplied free of charge or at reduced cost by the buyer,
  • For use in connection with the production and sale of such goods,
  • To the extent such value is not already built into the price actually paid or payable,
  • Apportioned appropriately.

Specifically:

  • Clause (ii) covers “tools, dies, moulds, drawings, blue prints, technical maps and charts and similar items used in the production of such goods.”
  • Clause (iv) covers “engineering, development, art work, design work and plans and sketches undertaken elsewhere than in the factory of production and necessary for the production of such goods.”

From this, the Tribunal highlighted that several cumulative factual conditions must be satisfied before any free-supplied drawings/designs can be loaded into assessable value:

  • There must be an additional consideration flowing from buyer to assessee;
  • It must be supplied for use in connection with production and sale;
  • Under clause (ii), it must be used in production; under clause (iv), it must be necessary for production;
  • The value must be ascertained and apportioned, and
  • It can be added only if not already included in the negotiated price.

The expressions “used in the production” and “necessary for the production” impose deliberate limitations, excluding items that are only remotely connected with manufacture or merely convey customer specifications.

Tribunal’s analysis on inclusion of free customer drawings

Burden of proof on Revenue

The Tribunal relied on **Commissioner of Central Excise, Belgaum vs.